# Tobins Q

I understand how to calculate Tobin’s Q but I am reading conflicting instructions on how to interpret it in the CBOK:

According to economic theory, Tobin’s q is approximately equal to 1 in equilibrium. If it is greater than 1 for a company, the marketplace values the company’s assets at more than their replacement costs, so additional capital investment should be profitable for the company’s suppliers of financing. By contrast, a Tobin’s q below 1 indicates that further capital investment is unprofitable. Institute, CFA. 2015 CFA Level III Volume 3 Economic Analysis and Asset Allocation. Wiley Global Finance, 2014-07-14. VitalBook file.

Reading 17 Question 10 Answer: C is correct. A Tobin’s q value of less than 1, when 1 is used as a comparison point, indicates that the company is undervalued in the marketplace because it indicates an opportunity to buy assets at a price below their replacement cost.

I understand the argument both ways and I’m not sure how to intrepret it (for the purpose of the exam) moving forward.

I don’t see the conflict.

The first says that the market values the company at less than its replacement cost, and the second says that investors can buy the company’s assets (i.e., buy stock in the company) at a price below the replacement cost of those assets.

They’re saying the same thing.

"If it is greater than 1 … additional capital investment should be profitable"

"A Tobin’s q value of less than 1 … indicates that the company is undervalued in the marketplace because it indicates an opportunity to buy assets at a price below their replacement cost."

Yes, both are saying the company is valued below replacement cost when Tobin’s Q < 1 and more than replacement cost when Tobin’s Q > 1. But question 10 in the CBOK asked how to make an investment decision on the basis of that information. The reading indicated quite directly that “additional capital is profitable” when Tobin’s Q > 1, i.e. buy stock when Tobin’s Q is above 1. But the answer was to buy when Tobin’s Q is less than 1.

Thinking about this logically, if the company is a portfolio of its underlying assets and an investor can buy that portfolio for less than replacement value (the whole of the assets are valued below the sum of the parts) then the investor is buying at a discount and should realize a positive return (buy when < 1). On the other hand, if the market values the firm at less than its assets - that means exactly that the market believes the firm is using their assets inefficiently and that the firm itself is less valuable as a going concern than it is stripped down and liquidated. (buy only when > 1).

In practice, I think Tobin’s Q by itself is insufficient to make an investment decision. But for the purpose of a multiple choice question, if we only consider Tobin’s Q in our investment recommendation, do we buy when Tobin’s Q < 1 or > 1?

Thanks s2000 for the confirmation.

But seperate from the exam there is a point highlighted above that in case if Q<1, then market believes the firm is using their assets inefficiently and that the firm itself is less valuable as a whole.

May be it depends, if we agree or disagree with the market view - like we feel there is a potential buying opportunity.

I also had a tough time understanding #10. Was about to post the question, but looks like this discussion already happened.

Still having a bit of a tough time concepualizing this.

if Tobins Q < 1 - Market believes that the firm is using its assets less efficiently. So the firm itself is less valuable as a whole.

This everyone agrees with.

It also thus implies that there is potential for negotiation. To bring down the price - if the firm thinks it is worth 1 Mill \$ but you know the firm’s Tobin’s Q is 0.9 - you would start out with your buy bid @ 900K. Does that make sense?

You buy Undervalued, Sell Overvalued --> another way to interpret Tobins Q < 1.

This. Don’t see the conflict you mentioned.